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Grainger Misses Zacks Estimates

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W.W. Grainger, Inc. (GWW - Analyst Report) reported adjusted earnings per share of $2.81 for the third quarter 2012, which increased 12% year over year from $2.51 in the prior year quarter but fell short of the Zacks Consensus Estimate of $2.90.

Including a pre-tax reserve for a settlement to resolve pricing disclosure issues relating to government contracts, EPS in the quarter was $2.15. Compared to the prior year quarter’s EPS of $2.51, EPS in the current quarter posted a decline of 14%.

Operational Update

Revenues in the quarter were $2.28 billion, up 8% from $2.1 billion in the year-ago period. Revenues fell short of the Zacks Consensus Estimate of $2.31 billion. The improvement in revenue in the quarter was attributed to volume growth and acquisitions, partly offset unfavorable foreign exchange. On a daily basis, sales improved 11% in July, 10% in August and 9% in September.

Revenues from the United States segment increased 4% year over year to $1.78 billion, driven by favorable volume and price growth. On a daily basis, sales increased 6% in July, 4% in August and 6% in September. Operating income (excluding the reserve) rose 7% to $310.7 million, mainly due to higher sales and gross margins.

Revenues from the Acklands-Grainger business in Canada climbed 10% to $272.9 million, due to improvements in the commercial services, oil and gas, contractor and utilities end markets. On a daily basis, segment sales increased 16% in July, 13% in August and 11% in September. Operating income in Canada expanded 37% to $34 million as a result of strong sales, improvement in gross margins as well as positive leverage in operating expense.

Revenues from Other businesses (which include Asia, Europe and Latin America) increased to $254.8 million from $168.2 million in the year ago quarter, driven by strong growth in Japan and Mexico as well as incremental sales from the Fabory and AnFreixo acquisitions.

Sales for Other Businesses increased 20% excluding the effect of the acquisitions. Operating earnings decreased 17% to $9 million as strong earnings growth in Japan and Mexico was offset by small operating losses incurred in Europe and Brazil..

Financial Position

Grainger had cash and cash equivalents of $420.8 million as of September 30, 2012, compared with $249.7 million as of June 30, 2012. Long-term debt was worth $479.7 million as of June 30, 2012, compared with $473.5 million as of June 30, 2012.

The company generated net cash of $338 million from operating activities in the reported quarter, up from $251 million in the prior-year quarter. Grainger expended $59 million as capital expenditures in the third quarter of 2012 compared to $47 million in the year-ago quarter.

Grainger paid dividends worth $57 million in the reported quarter and expended $85 million for the buyback of 421,000 shares. The company has approximately 5.6 million shares remaining on its share repurchase authorization.

Outlook

For 2012, the company trimmed its forecast of sales growth in the range of 11% to 12% from the previous guidance of between 12% and 14% due to weak economy. Grainger however reaffirmed its EPS guidance range of $10.50 to $10.80.

Our Take

Grainger remains focused on expanding its product offerings and growing the share of its private label products. The company currently offers 413,000 products and has a long-term vision to expand the product count to 500,000 by 2015. The company has historically seen growth of approximately 2% per year on sales from products added through the program.

Grainger also focuses on expansion programs for strengthening its businesses in each of its operating regions, mainly in Asia and Latin America. Revenues from Other Businesses continue its solid growth run, reflecting strong growth in Japan and Mexico and acquisitions.

However, the recent slowdown in the sales growth rate raises our concern. Margins are expected to remain under pressure due to Grainger’s accelerated investments in product line expansion, sales force expansion, eCommerce, inventory services, distribution centers and international expansion. The company currently retains a Zacks #4 Rank (short-term Sell recommendation).

Illinois-based Grainger is a leading North American distributor of material handling equipment including safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, etc. The company’s services comprise inventory management and energy efficiency solutions.

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